Production Possibilities Curve

Posted on: 11 Aug, 2017

Keeping track of your business is important; it allows you to accurately analyze its productivity. It allows you to identify problems and recognize any potential improvements. When it comes to production, there are several graphical representations that allow you to balance between the products you produce. It is generally a good idea to use multiple graphs in order to have a clear overview of your various products. Today we will be discussing the production possibilities curve which allows you to compare two products that share common resources in order to balance the amount of each. It is a measure of the efficiency of your current operation regarding the available resources and the amount of 2 products produced. Ensuring that your operation is working at maximum efficiency means that you are utilizing all your resources. Naturally, this means that you maximize your output (and profits) while minimizing unused resources which might otherwise go to waste. Now, in order to begin, let us understand the production possibilities curve.

What Is a Production Possibilities Curve ?

The definition of production possibilities curve is a graphical representation combining two products that share common resources in your operation. It shows the maximum amount output that is possible for both products which you can then compare to your actual output to ensure that there are no inefficiencies occurring. To understand the production possibilities curve, you must consider the opportunity cost. According to the concept of scarcity, your business only has a limited amount of resources that must be utilized to create your outputs. In order to allocate resource to one production, it must be removed from another. Likewise, Buying too much material while not outputting all of it into a sell-able product is considered to be a waste of money that could otherwise be used on something else. It is important to know which of your products to prioritize over another one. For a growing company, that is an incredible loss. Now, let us identify how a production possibilities curve is constructed:

1- each axis has the quantity of one of the common products

2- A table of supposed quantities that your operation can produce is sketched onto the graph. Observe the following table in order to understand the construction of the curve. For simplicity’s sake, let’s assume that your business’s only resource is labor (a maximum of 6 workers).

Labor Product 1

Labor Product 2

Quantity Product 1

Quantity Product 2

A

6

0

50

0

B

5

1

47

1

C

4

2

42

2

D

3

3

35

3

E

2

4

20

4

F

0

6

0

5

3- By plotting these points on a graph, you will have your production possibilities curve. Our example looks like this:

The Pareto Efficiency

A concept that was named after the Italian economist Vilfredo Pareto. It states that any point under this curve is inefficient as you are not utilizing your resources to their full potential. On the other hand, points lying above that curve is impossible as it utilizes more resources than your business has. Based on these findings, if your points lie above the curve, it is likely to that there was an error in the report. Regarding points that lie below the curve, they show that your business is not working at maximum efficiency which require immediate attention. Inefficiency are a direct loss of profits and stunt the growth of your business.

Now let us observe the meaning of shifts in this curve.

A) Shift to the Right

This indicates an increase in the capacity of your business’s output. This could be because of the introduction of a new technology that allows for more production or the purchase of more tools needed to produce. A shift to the right is always a great thing, it indicates that your company’s production line is growing. In simple terms, a shift to the right is the result of an increase in output.

B) Shift to the Left

This indicates a decrease in the capacity of your business’s output. This could be the result of the loss of some of your resources. It is regarded as a decrease in the output of your business.

Production Possibility Curve and Economics

Not only is this curve important for internal business affairs. On a larger scale, this curve allows you to identify the current status of your market’s economy. By applying the amount produced of a basic product on the x-axis against the amount of a luxury product on the y-axis, the resulting point on the graph represents the current state of the market. This information is important for your business as it will allow you to know which type of products to focus on producing. It allows you to know the consumer demand which is valuable to the success of your business. If the point is closer to the x-axis then the demand has shifted towards luxury, indicating that the market is flourishing and there are a lot of potential customers. Similarly, if the point is close to the y-axis then there is a higher demand for basic products. This indicated that the market’s economy isn’t doing so well and you should focus on essential products since there is no buying power.

Overview

The production possibilities curve is a powerful graphical representation of the theoretical output of your production. It considers 2 conflicting products and allows you to decide on the perfect balance between them. Furthermore, your actual production may be represented as a point on that graph in order to allow you to know where your business stands right now in regards to efficiency. In addition, the production possibilities curve can give you a general idea of the status of your potential market. By comparing luxury to essential goods, you can tell how well the market is doing. This is not the only available statistical tool, but it can prove quite useful. Complementing this with these budgeting tips and our project management checklist will ensure that your business is of maximum productivity and efficiency.